Financial Solutions Group Wealth & Risk Management Services, LLC

Wage Growth: Watching for a Tipping Point

In April 2018, average hourly earnings for private-sector U.S. workers grew at a 2.6% annual rate, and “real” wage growth (adjusted for inflation) increased just 0.2% year over year. The unemployment rate fell to 3.9% in the same month, a 17-year low that leaves many people wondering why workers are not seeing corresponding wage increases.1

Wage gains usually go hand in hand with low unemployment, primarily because employers must often raise pay to keep valuable employees and compete for new workers. For example, the last time unemployment fell below 4.0% was in December 2000, when wages were growing at a brisk 4.3%.2

An April 2018 survey of leading economists conducted by The Wall Street Journal identified three major factors contributing to slower wage growth: globalization, demographic changes, and low productivity growth.3 Here’s a closer look at how these forces could be restraining workers’ wages.

Globalization Effects

Globalization allows companies to shift production to less-developed nations where workers earn lower wages. It also means U.S. companies must contend with foreign competition. Globalization hit workers in the manufacturing industry especially hard in recent decades, and has generally weakened the bargaining power of the remaining U.S. factory workers.4

There are wide differences in living standards and prevailing wages among the world’s nations, and U.S. consumers generally prefer cheaper products. The complexity of the global marketplace will continue to influence business decisions and the performance of the U.S. economy.

Demographic Dilemma

After dominating the workforce for nearly 40 years, baby boomers are retiring at a rate of around 1.2 million a year, about three times more than a decade ago.5 A Federal Reserve study found that retiring boomers are often being replaced with younger, lower-paid workers.6

It’s likely that this trend has helped employers contain labor costs, which is reflected in nationwide measures that track the average wage. The transition from experienced to less-experienced workers may also be dampening productivity.

Productivity Pressure

In 2017, U.S. worker productivity grew just 1.2%, which was about the same as in 2016 and right around the 10-year average. It was the seventh year in a row that productivity growth fell below the 2.1% long-term average since 1947.7

Labor productivity is real economic output divided by the number of hours worked. Soft productivity growth makes it difficult for employers to justify pay increases for existing workers, partly because they must hire more workers to increase production.

While globalization and the aging of the U.S. workforce are long-term trends that can’t easily be reversed, a pickup in productivity could be on the horizon. There are expectations that some of the financial resources freed up by recent corporate tax cuts will be invested in innovative technology and/or better training that could boost worker productivity.

A nation’s gross domestic product (GDP) is essentially the number of workers times the productivity (output) per worker. With the U.S. workforce shrinking in relation to the total population, a large increase in worker productivity would be required for the economy to sustain an annual growth rate of 3% or more.

Economic Implications

Slow wage growth (especially when paired with rising inflation) can reduce consumer demand simply because workers have less disposable income to spend. Consumer spending, which accounts for almost 70% of U.S. economic activity, slowed to a somewhat discouraging 1.1% annual growth rate in the first quarter of 2018.8

Employers, investors, and economists, including policymakers at the Federal Reserve, are watching closely for a tipping point in wage growth. Eventually, upward pressure from a tight labor market could overcome longer-term structural restraints and push wages higher, followed by higher GDP growth and inflation.

Real U.S. GDP growth slowed from a 2.9% annual rate in the fourth quarter of 2017 to 2.3% in the first quarter of 2018, and the U.S. economy grew 2.3% overall in 2017.9 In the Federal Open Market Committee (FOMC) March 2018 summary of economic projections, the median forecast is for 2.7% GDP growth and 1.9% inflation in 2018. Given these expectations, the FOMC has signaled its intention to raise the benchmark federal funds rate two or three more times this year, bringing it up to a range of 2.1% to 2.4%.10

If wages rise sharply and the productivity slump continues, it could cut into company profits. Moreover, a strong surge in wages might prompt the Fed to raise interest rates more quickly in an effort to cool down the economy and keep inflation under control.

On a personal level, most people would be happy with a large wage increase. However, the ideal scenario for the health and stability of the U.S. economy — and the workers, employers, and investors who depend on it — may be the continuation of steady, moderate wage gains.